Two Articles on the New Capital Gains Tax Law


Many homeowners can sell their principal residence free of any federal income tax consequences. As the result of the recent tax change, upon the sale of a qualifying prinicipal residence, a gain of up to $250,000 or up to $500,000 on many jointly filed tax returns will be exempt from federal income taxation The residence sold must have been owned and have been the residence of the seller for two of the least five years proceeding the sale.

There are other limits that apply to taxpayers who want to take advantage of this favorable treatment; First, this exclusion is available once every two years-in most cases; and the exclusion does not apply to the recapture of depreciation. This means that if your home was rented out or used for a business operation and you claimed a deduction for depreciations you could still be subject to a tax upon the sale. For many taxpayers, this new rule effectively eliminates the need to keep meticulous records (for tax purposes) of their home purchase and improvements, assuming the gain will never exceed the $250,000 or $500,000 tax-free amount. However, this may not obviate the need to keep good records for insurance and other purposes. The above rule only applies to a qualified primary residence, not to a second vacation home. Note also, that if a person had previously used the old rule that allowed the gain on such a sale to be rolled over, then the income tax basis of the current house (the cost of the current house being sold for capital gain) is probably less than the amount actually paid for the home. That lower basis is the measuring point for the exclusion of gain under the new rules.

(reprinted from the 01/22/98 issue of the New York Times)

LAST year, the Federal Government gave an extraordinary gift to most homeowners by excluding from taxation as much as $500,000 in gain on the sale of a principal residence.

But that does not mean that everyone who sells a home at a profit will get a half-million dollar tax-free ride. In fact, tax experts say, factors such as marital status, the date of the sale, the present or former use of the property and even the state where the property is located (New Jersey taxes such gains) could have an impact on the tax that sellers will ultimately pay - or not pay - when selling their residence.

"While most homeowners will benefit front the new tax law, many may still find themselves in a taxable situation when they sell their home, ' said Abe Kleiman, a Manhattan certified public accountant.

The most significant limiting factor of the new law Mr. Kleiman said, has to do with the marital status of the owners. Generally, he said, married couples who file jointly can exclude up to $500,000 in gain from taxable income - even if the home is in the name of only one of the individuals. Single taxpayers, Mr. Kleiman said, are allowed to exclude up to $250,000 in gain. Married taxpayers who file individually - in order, for example, to have the ability to deduct medical expenses incurred by a spouse with a minimal income - are also allowed exclusions of $250,000 each, said Mr. Kleiman. One limitation of the new law, he said, is that it eliminates a rather generous element of the old one.

The two-year rollover provision is gone," Mr. Kleiman said, referring to a portion of the old law that allowed sellers to defer paying capital gains taxes on the sale of a principal residence if they invested the proceeds in a replacement dwelling of equal or greater value within two years.

Under the new law, however, any gain in excess of the applicable exclusion may be Subject to tax.

"It's probably not so difficult to imagine older people who have a home worth $700,000 or $800,000 today, to have a cost basis of $50,000 or $100,000 if they bought their first home 40 years ago," he said. In such situations he added, couples will likely find that they are subject to taxation on any gain that exceeds $500,000 - or worse - $250,000 if the seller is an individual.

Moreover, he said, in situations where one spouse dies, and the surviving spouse has been the sole owner of the property, he or she would have to sell the property in the year the spouse died to qualify for the full $500,000 exclusion. Mr. Kleiman said the reason for this is that a joint return can only be filed for a year that both spouses are alive.

Timing is important.

Joel E. Miller, a Queens tax lawyer, said that for a seller to be eligible for the maximum exclusion under the new law, the property must have been sold after May 6, 1997, and must have been owned and occupied as a principal residence for at least two of the five years preceding the sale.

However, Mr. Miller said, taxpayers who sold their home after May 6, but on or before Aug. 5, 1997 - as well as those who sold homes after Aug. 5 under a contract that was binding on that date - can elect to take the exclusion provided under the new law or to roll over their gain into a replacement dwelling within two years of the date of the sale.

Mr. Miller cautioned, however, that homeowners in such a situation should carefully consider the long-term impact of choosing to roll over their gain.

For example, Mr. Miller said, a married couple with a $100,000 cost basis in a home they sold during the "window period" for $700,000 would have a gain of $600,000 - leaving $100,000 subject to taxation after the $500,000 exclusion. If the couple elects to "roll over" the gain into a $700,000 replacement dwelling, the tax on the gain is deferred until the replacement dwelling is sold.

If the replacement dwelling is sold for $800,000, the couple will then be subject to taxation on $200,000 of their $700,000 gain after taking their $500,000 exclusion. On the other hand, Mr. Miller said, if the couple had chosen not to roll over their gain into a replacement dwelling, but instead bit the bullet and paid the tax on the original $100,000 profit, they would have to pay no additional tax on the sale of the replacement dwelling because they would get a new $500,000 exclusion on that sale.

Another factor that may limit a seller's total tax savings has to do with location of the property. While New York and Connecticut generally follow the same capital gains tax rules as the Federal Government, New Jersey, for one state, does not.

According to Dan Emmer, a spokesman for the New Jersey Division of Taxation, property owners who sell their New Jersey residences at a profit have to include their total gain in their New Jersey taxable income, even if is excluded for Federal tax purposes. Mr. Emmer said that he was not aware of any pending or proposed legislation that would change that rule.

He noted that the homeowner can still defer taxes by rolling over the profit into a replacement within two years.

Finally, even the use of a property - both present and former - can have an impact on the tax that may be due upon sale.

Martin Shenkman, a Teaneck, N.J., tax lawyer, said that those who use a portion of their home for business purposes - such as a home office or rental property - must pay tax on the gain attributable to the portion of the home used for business.

For example, Mr Shenkman said, if half of a two-family house is rented out, only the half used as a personal residence is eligible for the capital gains-tax exclusion; the rental portion is not. Accordingly, he said a homeowner with a $100,000 basis in such a house who then sells the house for $300,000 would have to pay tax on $100,000 of the $200,000 gain. The same general result would occur - but in appropriately different proportions - if part of the home is used as a home office.

One common way to avoid such a result, Mr. Shenkman said, is to discontinue the business use for at least two years prior to the sale, thereby making it possible to treat the entire house as a principal residence. In such a situation, he said, the seller must still account for any depreciation deductions "allowed or allowable" on the business portion of the home.

That means that any depreciation deduction that should have been taken for the business use of the property - whether a deduction was actually taken or not - must be used to reduce the cost basis of the property, thereby increasing the gain subject to taxation.

Under the new law, Mr. Shenkman said, depreciation deductions taken before May 7, 1997, are treated as before - as reductions to the basis that increases gain. The increase in gain, however, can be offset by the exclusion available under the new law.

But depreciation deductions taken from May 7 onward cannot be offset by the exclusion, but must be included in taxable income. That means, Mr. Shenkman said, that anyone taking a home-office deduction after May 7 should discuss the matter with his or her tax adviser.

In fact, he said, as generous as the new law seems, it should not lull homeowners into a false sense of security. There is no guarantee, he said, that the $250,000/$500,000 exclusion, which seems like a lot of money now, will be sufficient to cover accrued gains realized 20 or 30 years in the future.

"Every homeowner still has to keep detailed records and crunch the numbers when it comes time to sell," he said.

Home | Table of Contents | Top of Page | Contact Us
Teran Realty · 74 Mill Hill Road · Woodstock, NY 12498
(845) 679-3333 · 1-800-57-TERAN